Question

On July 1, 2010, a company obtained a £10,000 one year loan with an interest rate of 10%. The principal and interest will be paid at the due date, June 30, 2011. The firm’s fiscal year end is on December 31st. The company did not record any entries related to this transaction.

As a result,

a. Liabilities are understated by £10,000, assets are understated by £10,000, and income before taxes is correct.

b. Liabilities are understated by £10,000, assets are understated by £10,000 and income before taxes is understated by £500.

c. Liabilities are understated by £10,500, assets are understated by £10,000 and income before taxes is overstated by £500.

d. Liabilities are understated by 10,000, assets are understated by £9,500 and income before taxes is overstated by 500.

Answer 1

From the options OPTION C is correct

When the entity is receiving amount as loan the following entry should record on that date

Bank account Dr £10000

To loan account £10000

By not recording this entry entity shows Assests understated by £10000 and understatement of loan by £10000

And the entity also book interest for the period of 6 months this also not done resulted into overstated of income by £500

Interest calculation is as follows

Interest rate is 10% (assuming per annum)

Therefore for 6 months interest rate is 5%

Interest= £10,000×5%=£500